Japanification
December 07
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Here are some of the biggest stories from last week:
Dig deeper into these stories in this week’s review.
Higher interest rates were meant to make it more difficult for companies to raise capital. Instead, soaring share prices and falling corporate bond yields has sent an index of US financial conditions to its lowest level since November 2021.
See, interest rates aren't the sole determinants of financial conditions. While higher rates usually mean more expensive loans, many other factors also impact how easily firms can secure financing and keep economic growth going. These include the cost for companies to borrow compared to governments (i.e. credit spreads) and how well the stock market is doing (since issuing equity is another key source of financing).
Meet the Chicago Fed’s National Financial Conditions index: it measures how easily companies can raise cash by looking at more than 100 indicators across money, debt, and equity markets. There are two crucial aspects to understanding the index. First, a rising value indicates tightening financial conditions, while a decline indicates easing conditions. Second, positive values denote tighter-than-average conditions compared to historical norms, whereas negative values indicate looser-than-average conditions.
The latest reading showed the index decreased to -0.56 in the week ending May 17 – its lowest level in two and a half years. That came after data last week showed US inflation was slightly cooler than expected in April, which sent bond yields lower and US stocks to a record high as traders increased their bets on rate cuts this year.
But here's another interesting point from the chart: although the index increased in 2022 and 2023 due to the Fed's rate hikes, the index stayed in negative territory throughout this period. Put differently, financial conditions were still looser than average despite rising borrowing costs. This could be another reason why the US economy avoided a recession. After all, with companies still finding it easy to raise cash, they wouldn’t have had to cut back on their investments – a key driver of economic growth.
Over in the UK, new data this week showed the country’s annual inflation rate slowed to 2.3% in April, reaching its lowest level in almost three years. But that was above the 2.1% pace that economists and the Bank of England had expected. What’s more, core inflation, which excludes volatile food and energy prices, also decelerated by less than economists had forecast, to 3.9%. Adding to the bad news, services inflation – a measure closely watched by the BoE for signs of domestic price pressures – ticked down only slightly to 5.9%, which was far above the 5.5% economists and the central bank were hoping for.
The hotter-than-expected figures prompted traders to back away from bets that the BoE would lower interest rates, which stand at a 16-year high of 5.25%, this summer. They had been evenly split on the chance of a rate cut by June ahead of the inflation report, but now place the likelihood of a reduction by August at less than 50%.
The growing buzz around generative AI has forced tech companies to replace their post-pandemic cost-cutting programs with huge, investor-approved spending plans on data centers. The result is a huge increase in capital expenditure, much of it directed toward gross plant, property, and equipment (PP&E) – a balance sheet line item that reflects the value of their investments in fixed assets, before depreciation.
Between the end of 2019 and the 2023 fiscal year, gross PP&E at Meta, Amazon, and Microsoft more than doubled, and it nearly doubled at Alphabet. Apple stands out as an outlier, with PP&E increasing by less than a third between 2019 and 2023. After all, the company has yet to finalize its generative AI strategy (and is being penalized by investors as a result).
But here’s the thing about all that spending: when a business buys a big-ticket item, the depreciation (the value an item loses each year) counts as an annual expense in subsequent years. That means Big Tech’s massive splurge on data centers will show up in rising depreciation expenses down the road, which could dent profit margins unless revenue increases by an equal amount.
Aware of this, Big Tech firms have been sneakily extending the estimated life of their servers to five or six years – an accounting change that added almost $10 billion to Microsoft, Google, Meta, and Amazon’s profits in the past two years. But there’s a limit to how far this can go, with many industry experts saying that servers have to be replaced after five years. In other words, Big Tech cannot rely on accounting shenanigans much further to cushion the blow from all those depreciation expenses.
Speaking of Big Tech and AI, Nvidia reported its hotly awaited quarterly results on Wednesday, and it didn’t disappoint. The chipmaker made $26 billion in revenue last quarter – 18% more than the period before and topping predictions of $24.7 billion. What’s more, the company said the next set of results would be even better, forecasting sales of $28 billion – above analyst expectations of $26.8 billion. Investors sent Nvidia’s stock higher after the news, taking it above $1,000 for the first time and meaning it’s now doubled this year after more than tripling in 2023. Incidentally, the company announced a 10-for-1 stock split on Wednesday, which should make the shares more accessible and affordable for smaller investors.
Copper futures on the London Metal Exchange topped $11,000 a metric ton for the first time ever on Monday, extending a months-long rally fueled by investors piling into the market in anticipation of deepening supply shortages.
See, demand for copper – used in renewable energy plants, power cables, and EVs – is booming, driven by megatrends like decarbonization. Problem is, production from existing mines is set to fall sharply in the coming years, and firms aren’t investing enough to offset the drop off – let alone grow supply. Instead, they’re arguably more interested in buying out rivals with copper exposure than building out their own production, as evidenced by BHP’s attempted takeover of Anglo American.
Anticipating all those factors, investors started flocking to the copper market in late March, causing prices to take off. But the rally went into overdrive last week when a short squeeze on the New York futures market triggered a global rush to secure the metal. Traders there had been betting on copper to fall, saying that prices were running ahead of reality. After all, current demand – as opposed to that in a few years, when the energy transition gathers speed – looks weak, particularly in China, which accounts for about half of the world’s copper consumption.
But the spike in prices wrongfooted those traders, forcing them to scramble to cover their short positions by buying back copper futures. That only added more fuel to the fire, and pushed the difference between copper prices in the US and the global benchmark in London to a record gap of more than $1,000 a ton (the gap between the two is typically less than $90). That triggered a rush to reroute copper to the US, meaning less metal available elsewhere and pushing global prices even higher.
General Disclaimer
This content is for informational purposes only and does not constitute financial advice or a recommendation to buy or sell. Investments carry risks, including the potential loss of capital. Past performance is not indicative of future results. Before making investment decisions, consider your financial objectives or consult a qualified financial advisor.
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